Comparative Advantage

by on July 1, 2014 at 7:31 am in Economics, Education | Permalink

Don Boudreaux’s Everyday Economics video on comparative advantage is one of the best introductions to comparative advantage that I know of in any format.

(The series is a product of MRU but I cannot take any credit for its creation.)

Robert Sandor July 1, 2014 at 7:42 am

This is one of the best video series I have ever seen on economics. The visuals make it interesting and accessible. Keep up the great work!

Reply

dearieme July 1, 2014 at 8:22 am

Shame on him for the inverted commas finger-gesture around “discovered”: moral cowardice I suppose.

Reply

Alex July 1, 2014 at 9:36 am

This was a very good video Professor Boudreaux. You failed to come back to the Tanzmanians though. Briefly explaining why they lost technologies and didn’t invent new ones would have tied up the video nicely.

Reply

Brian Donohue July 1, 2014 at 10:11 am

Agreed. The example felt belabored a bit, than it didn’t complete the follow through either: Ann improves at fish-catching, Bob is better off.

The Tasmanian story is highly engaging- shoulda closed the loop.

Good effort though.

Reply

Alex Tabarrok July 1, 2014 at 10:18 am

Point taken but the Tasmania bit is really building off the two earlier pieces on the division of labor.

Reply

dave smith July 1, 2014 at 11:31 am

And it leaves something for us who will be using these videos to do in class!

Reply

Ray Lopez July 1, 2014 at 11:41 am

History shows (UK, US, others) that comparative advantage does not work in practice. In practice, specializing in one thing leads to dependence and opens one up to exploitation (US Deep South, South of the Border nations, etc).

And apparently, if Wikipedia is to be believed, the Tasmanian narrative by Dr. Don is in fact wrong, see: http://en.wikipedia.org/wiki/Tasmanian_Aborigines#Before_European_settlement

In fact, the Tasmanians may have lived in a land of milk and honey where there was no need to fish or employ boomerangs and so forth. The land of the Lotus Eaters.

Reply

Mike July 2, 2014 at 8:05 am

This was my thought as well, though clicking on the link has a brief intro to the video which includes:

“When Tasmania was cut off from mainland Australia, it experienced the miracle of growth in reverse, as the reduction in trade and human cooperation forced its inhabitants back to the most basic ways of living.”

Reply

Dismalist July 1, 2014 at 10:22 am

The arithmetic example, while correct have been even more illuminating if Bob were less productive in both fish and bananas: .

Reply

Jon July 1, 2014 at 10:22 am

I still dont understand comparative advantage between nations. In 1950, who could have known that Taiwan, Korea, Japan and Singapore, and now China are the countries best suited for producing high tech manufacturing? Singapore especially they were just some fishermen in 1950. Comparative advantage dictated they would be fishermen, as they has good fishermen skills. It would be better for america to produce high tech not asia??? But it seems its the other way around.

Reply

derek July 1, 2014 at 10:45 am

That was the situation then. For decades the US was known for high quality low cost manufactured goods. But remember, Japan was an industrial powerhouse that produced a very impressive engine of war, so they weren’t backwards uneducated unskilled fishermen. Without the distraction of militarism they were able to focus their energies on building a low cost high quality manufacturing economy, at the time when the US was changing to a low cost low quality manufacturing economy in some sectors. It is as if bob found a way to get fish cheaper than trading bananas with ann.

This concept is describing a moment in time. In a year the comparative advantage might have changed.

There is another alternative to Boudreaux’ story. Bob gets better at catching fish. Ann finds it cheaper to get fish from Bob than catching them herself. Ann goes out of business.

Reply

jon July 1, 2014 at 1:51 pm

But these countries only got there by import restrictions, basically curtailing free trade, the opposite of what comparative advantage says is positive for the world. China is a country with the heaviest import restrictions in the world. Japan and korea also have heavy import restrictions, more than countries on average have.
So by negating comparative advantage it is negative for the world but positive for China? So free trade is bad but also good… conflicting messages.

Reply

mulp July 1, 2014 at 1:04 pm

Government policy was to change the comparative advantage.

I was selling/supporting the steel industry in the 70s and still paying attention in the 80s are recall the economists explaining how stupid the government of Korea and then China was to invest in steel making when the US and Europe already had excess steel production capacity, and their venture into steel making was going to lead to a heavy drain on the government treasuries to prop up industries that would never be able to operate at full capacity. Further, the claim was made they would never be able to deliver the quality of the US/Europe.

The same things were said about government initiatives into automaking, electronics, household appliances, on and on.

Dictators and authoritarians can grasp the fundamental benefits of capitalism and free markets without embracing the society the champions of free market capitalism think must exist for them to operate. Milton Friedman grasped that in his examples around Chile and Hong Kong. But the far better case is China, but it follows Korea and Taiwan – the governments were faced with high inequality and the turmoil that would create eventually of depending on low wage production to feed the trade in the high value goods the leaders and elites wanted and needed (weapons to control), or they ensure the nation change its comparative advantage. Instead of growing food in exchange for manufactured goods from the US, they now trade manufactured goods for food from the US where the vast land in the US allows inefficient food production with low labor cost while they shift high labor input from farming to manufacturing.

Of course, the more interesting trade is the one where the US trades pieces of paper with stuff printed on them that cost a few cents to make for a few gallons of black liquid taken from the ground and then the rest of the world holds those pieces of paper as if they are worth something while we burn the black liquid in a matter of days and have nothing left to show for it. Although, the Supreme Court did rule that government absolutely must honor those pieces of paper with stuff printed on them so no matter how far in the past we burned up the black liquid we still need to deliver something of real value on demand.

Reply

Yancey Ward July 1, 2014 at 6:56 pm

No wonder the US steel industry tanked- Mulp was working in it.

Reply

Clover July 1, 2014 at 4:39 pm

Those countries didn’t have a comparative advantage in those things, and that’s why they needed import restrictions and subsidies to grow. As I said in my comment below, industries like high tech manufacturing have positive externalities that their natural market price(i.e. return on capital investment to the owners), does not reflect.

Reply

Dismalist July 1, 2014 at 10:22 am

The arithmetic example, while correct, would have been even more illuminating if Bob were less productive in both fish and bananas.

Reply

cfh July 1, 2014 at 11:47 am

If Bob will trade 1 fish for 1 banana, why is Ann paying him so much more than that?

Reply

dave smith July 1, 2014 at 11:51 am

cfh, if your question is serious, here is an answer: the terms of trade will be somewhere between 1:1 and 1:3 depending on the bargaining power (which is influenced by many things) of Ann and Bob. The theroy can’t predict what that will be.

Reply

cfh July 1, 2014 at 12:08 pm

Nope, not serious. But if we take the Bob/Ann example on its own terms, there is no reason for Ann to pay more than 1 fish, even if she’s otherwise willing to bid much higher.

Reply

Clover July 1, 2014 at 4:28 pm

Here is a theoretical refutation of free trade:

Suppose you have a capitalist in Nation A who wants to invest an amount of capital in one of two industries, Industry X and Industry Y. The expected rate of return on his investment in either industry is roughly equivalent. However, Industry Y hires more workers in the Nation than Industry X, and pays them a higher average wages. Industry Y will purchase more goods and services in the Nation A than Industry X, which will import more of its goods and services from abroad. For the capitalist, the decision about which industry to invest his money in is a toss up, because all a capitalist cares about is the rate of return on his capital.(In theory) However, which industry would Nation A, if it is self-interested, rather have? Obviously, it would rather have the industry that hires more of it’s workers and pays them better, and buys more goods and services from within the Nation’s businesses.

This demonstrates how the prisoner’s dilemma works in international trade, in theory the most efficient system might be free trade, but to a given nation defection from the system of free trade would be most beneficial. Trade barriers work in a similar way. If you have a furniture manufacturer that can buy lumber from abroad or lumber from within the Nation, and both sell for the same price, having a tariff will raise the price of lumber imported and lead the manufacturer to use local lumber, benefiting the local economy.(You can also see how this naturally refutes the reductio ad absurdum argument, if within nation lumber costs three times as much as foreign lumber, and tariffs are raised to reflect that, obviously that will hurt the manufacturer greatly)

Technology and innovation is another area where free trade does not make sense. You might have two possible industries, Automobile production and fishing. Both might have the same rate of return on capital, same net economic benefit to the nations citizens and business. But with automobile production you would hire and train more engineers, rather than fishermen. With more engineers you would have a more innovative population. This would not necessarily be factored into the return on capital for the automobile producer. The trained engineers might leave the companies and then build their own businesses, these businesses do not help the automobile manufacturer but do help the greater economy. If you can see the value in public sector education, you should be able to see why private training and employment(which creates demand for education) should also be valued. This is why many countries give help to these types of innovative industries, such as tax reductions and tariffs.

Reply

sort_of_knowledgable July 1, 2014 at 5:25 pm

If both industries have the same rate of return then it is unlikely there is a comparative advantage.

Reply

Benny Lava July 1, 2014 at 7:37 pm

While free trade is usually good economist still haven’t even considered the contradiction between absolute advantage and supply and demand of labor. Maybe one day economics will grow up?

Reply

Leave a Comment

Previous post:

Next post: